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India Should Rely on Lower Rates to Stimulate Growth, OECD Says

by Kartik Goyal

June 24 (Bloomberg) — India should cut interest rates
rather than boost government spending if further measures are
needed to stimulate growth, the Organization for Economic
Cooperation and Development said.

They need to read Bernanke’s 2004 paper which makes it clear lower interest rates are contractionary via the fiscal channel and need to be matched by fiscal expansion to overcome that effect.

Additionally, in today’s environment, lower rates hurt savers a lot more than the help borrowers. Rates for savers have fallen a lot more than rates for borrowers due to risk perceptions and implied capital costs as net interest margins for lenders have increased to over 4%. This also means reduced aggregate demand and begs additional fiscal measures to sustain GDP.

So while I strongly favor lower rates, I also recognize that one of the benefits of lower rates is that they allow reduced taxes or increased public expenditure to sustain output and employment at desired levels.

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Karim writes:

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Please send this on to Eugenio Aleman at Wells Fargo

Thinking The Unthinkable: The Treasury Black Swan, And The LIBOR-UST Inversion

Posted by Tyler Durden

>   The below piece is a good analysis of a hypothetical Treasury/Dollar black swan
>   event, courtesy of Eugenio Aleman from, surprisngly, Wells Fargo. Eugenio does
>   the classic Taleb thought experiment: what happens if the unthinkable become
>    not just thinkable, but reality. Agree or disagree, now that we have gotten to
>   a point where 6 sigma events are a daily ocurrence, it might be prudent to
>   consider all the alternatives.

In previous reports, I have touched upon the concerns I have regarding the overstretching of the federal government as well as of monetary policy while the Federal Reserve tries to maintain its independence and its ability, or willingness, to dry the U.S. economy of the current excess liquidity.

Excess reserves are functionally one day Treasury securities.
It’s a non issue.

Furthermore, we heard this week the Fed Chairman’s congressional testimony on the perils of excessive fiscal deficits and the effects these deficits are having on interest rates at a time when the Federal Reserve is intervening in the economy to try to keep interest rates low.

His thinking is still on the gold standard in too many ways.

Now, what I call “thinking the unthinkable” is what if, because of all these issues, individuals across the world start dumping U.S. dollar notes, i.e., U.S. dollar bills?

The dollar would go down for a while.
Prices of imports would go up.
Exports would go up for a while

All assuming the other nations would let their currencies appreciate and let their exporters lose their hard won US market shares, which is certainly possible, though far from a sure thing.

Why? Because one of the advantages the U.S. Federal Reserve has over almost all of the rest of the world’s central banks is that there seems to be an almost infinite demand for U.S. dollars in the world, which has made the Federal Reserve’s job a lot easier than that of other central banks, even those from developed countries.

In what way? They set rates, that’s all. It’s no harder or easier for the Fed than any other central bank.

if there is a massive run against the U.S. dollar across the world then the Federal Reserve will have to sell U.S. Treasuries to exchange for those U.S. dollars being returned to the country, which means that the U.S. Federal debt and interest payments on that debt will increase further.

Not true. First, they have a zero rate policy anyway so they can just sit as excess reserves should anyone deposit them in a bank account, and earn 0. Or they can hold the cash and earn 0.

This means that we will go from paying nothing on our “currency” loans to having to pay interest on those U.S. Treasuries that will be used to sterilize the massive influx of U.S. dollar bills into the U.S. economy, putting further pressure on interest rates.

No treasuries have to sold to sterilize anything.
A little knowledge about monetary operations would go a long way towards not letting this nonsense be published in respectable forums.

If we add the nervousness from Chinese officials regarding U.S. debt issues, then we understand the reason why we had Treasury secretary Timothy Geithner in China last week “calming” Chinese officials concerned with the massive U.S. fiscal deficits. I remember similar trips from the Bush administration’s Treasury officials pleading with Chinese officials for them to continue to buy GSEs (Freddie Mac and Freddie Mae) paper just before the financial markets imploded.

Yes, they have it wrong, and it’s making the administration negotiate from a perceived position of weakness while the Chinese and others take us for fools.

But the situation today is even more delicate because of the impressive amounts of U.S. Treasuries s we will have to issue during the next several years in order to pay for all the programs we have put together to minimize the fallout from this crisis.

Issuing Treasuries does not pay for anything. Spending pays for things, and spending is not operationally constrained by revenues.

The Treasuries issued support interest rates. They don’t ‘provide’ funds.

Furthermore, if China and other countries do not keep buying U.S. Treasuries, then interest rates are going to skyrocket.

There’s some hard scientific analysis. They go to the next highest bidder. The funds to pay for the securities come from government spending/Fed lending, so by definition the funds are always there and the term structure of rates is a matter of indifference levels predicated on future fed rate decisions.

This is one of the reasons why Bernanke was so adamant against fiscal deficits in his latest congressional appearance.

And because on a gold standard deficits can be deadly and cause default. He’s still largely in that paradigm that’s long gone.

Of course, the U.S. government knows that the Chinese are in a very difficult position: if they don’t buy U.S. Treasuries, then the Chinese currency is going to appreciate against the U.S. dollar and thus Chinese exports to the U.S., and consequently, Chinese economic growth will falter.

Yes, as I indicated above.

The U.S. and China are like Siamese twins joined at the chest and sharing one heart. This is something that will probably keep Chinese demand for Treasuries elevated during the next several years. However, this is not a guarantee, especially if the Chinese recovery is temporary and they have to keep on spending resources on more fiscal stimulus rather than on buying U.S. Treasuries.

Again, this shows no understanding of monetary operations and reserve accounting. The last two are not operationally or logically connected.

Thus, my perspective for the U.S. dollar is not very good. And now comes the caveat. Having said this, what is the next best thing? Hugo Chavez’s Venezuelan peso? Putin’s Russian rubble? The Iranian rial? The Chinese renminbi? Kirchner’s Argentine peso? Lula da Silva’s Brazilian real? That is, the U.S. dollar is still second to none!

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The ECB remains way ahead of the fed regarding monetary operations.
It has been setting rates and letting quantity adjust and now addresses
unfounded concerns of ‘exit strategies’ head on.

(I take issue only to the extent of the potential inflationary implications and influence on growth and employment of interest rate policy in general, but that’s another story.)

The covered bond purchase could have utilized a rate target rather than a quantity target but their policy might not be to target a specific rate.

Also note they accept collateral down to a bbb rating from their member banks, which is includes bank paper and is functionally very close to unsecured lending- a policy that i have been suggesting would have served the fed well from the beginning of the crisis.

Trichet Sees Automatic Exit From ECB’s Non-Standard Measures

June 5 (Bloomberg) — European Central Bank President Jean- Claude Trichet said banks will seek less credit from the ECB when the economy improves, automatically reducing the amount of money in the system and ensuring a non-inflationary recovery.

By concentrating its non-standard policy measures on the supply of unlimited liquidity to banks, the ECB has ensured it has “an in-built exit strategy,” Trichet said in a speech in Warsaw today. “That is, when tensions in financial markets ease, banks will automatically seek less credit from the ECB.

This will be a decisive element in ensuring a non-inflationary recovery.”

The Frankfurt-based ECB, which has cut its benchmark interest rate to a record low of 1 percent, has said it will loan banks as much money as they need for up to 12 months and pledged to buy 60 billion euros ($85 billion) of covered bonds in an effort to revive lending. The ECB yesterday lowered its economic forecasts for this year and next. It now expects the economy of the 16 nations using the euro to shrink by about 4.6 percent this year before returning to positive quarterly growth rates by mid-2010.

“Once the macroeconomic environment improves, the Governing Council will ensure that the measures taken can be quickly unwound and the liquidity provided absorbed,” Trichet said. “Hence, any threat to price stability over the medium and longer term will be effectively countered in a timely fashion.”

Merkel’s Warning

German Chancellor Angela Merkel on June 2 scolded the Federal Reserve and Bank of England for pumping too much money into their economies and said that by deciding to buy covered bonds, the ECB had “bowed somewhat to international pressure.”

She urged a return to a “policy of reason.”

Trichet said the ECB’s “bold yet solidly-anchored response” to the worst economic crisis since World War II is “encouraging.” While long-term inflation expectations remain anchored around the ECB’s 2 percent limit, “our measures show some signs of revival in the functioning of money markets in Europe,” he said.

Trichet added that the crisis has not altered the ECB’s primary objective of maintaining price stability. “This objective will always provide the context and limits within which our course of action is framed and enacted.”

Trichet Says ECB Will Buy Covered Bonds Next Month

by Neil Unmack

June 4 (Bloomberg) — The European Central Bank will start buying 60 billion euros ($85 billion) of three- to 10-year covered bonds from July, President Jean-Claude Trichet said.

The central bank will buy bonds rated at least BBB- in the primary and secondary markets until June 2010, but doesn’t plan to purchase other assets, the ECB said after policy makers held interest rates at a record-low 1 percent. The ECB said on May 7 it will buy covered bonds in a bid to revive the market, which lenders use to finance mortgages and public-sector loans.

Covered bond issuance increased after the ECB announced the purchase program last month, with banks selling 26.8 billion euros of the debt, according to data compiled by Bloomberg. The $2.8 trillion market had been roiled by the credit crisis, and sales had halved to 48.6 billion euros by May 7, compared with 99.4 billion euros in the same period a year earlier.

“It’s supportive for the primary and secondary covered bond market,” said Leef Dierks, a credit analyst at Barclays Capital in Frankfurt. “We expect the issuance window to remain open, and believe that the positive momentum in the secondary market will continue.”

To be included in the ECB’s purchase plan, covered bonds “must be eligible for use as collateral in the euro system’s credit operations,” Trichet said. The bonds must “have as a rule a volume of about 500 million euros or more and in any case not lower than 100 million euros,” he said.

Bond Eligibility

Bonds bought by the central bank must comply with the so- called UCITS directive, a European regulatory framework for mutual funds, or have “similar safeguards,” Trichet said, without being more specific.

“They want to get the most bang for their euro, and that means helping the bonds that will have the widest investor support in the market,” said Ted Lord, head of covered bonds at Barclays.

The ECB said it will buy bonds through “direct purchases” rather than following the Bank of England’s example of using auctions.

“We would like more clarity on how these direct purchases will work,” said Heiko Langer, a covered bond analyst at BNP Paribas SA in London. “Will we know how much they have bought, what they have bought, and at what price?”

Regarding the euro region’s economy, Trichet said confidence may improve more quickly than has been forecast.

“Risks to the economic outlook are balanced,” he said. “On the positive side” there are “stronger-than-anticipated effects from stimulus measures underway and other policy measures taken. Annual inflation rates are projected to decline further and become negative over the coming months.”

Covered bonds are backed by real-estate or public-sector debt and tend to have a higher rating than straight corporate bonds because they’re also supported by a borrower’s pledge to pay.

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The Euro is not trading far from levels that Trichet described as ‘brutal’ in the past.

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Don’t Monetize the Debt

by Mary Anastasia O’Grady

May 23 (WSJ) — From his perch high atop the palatial Dallas Federal Reserve Bank, overlooking what he calls “the most modern, efficient city in America,” Richard Fisher says he is always on the lookout for rising prices. But that’s not what’s worrying the bank’s president right now.

His bigger concern these days would seem to be what he calls “the perception of risk” that has been created by the Fed’s purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.

Mr. Fisher acknowledges that events in the financial markets last year required some unusual Fed action in the commercial lending market. But he says the longer-term debt, particularly the Treasurys, is making investors nervous. The looming challenge, he says, is to reassure markets that the Fed is not going to be “the handmaiden” to fiscal profligacy. “I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.”

If he actually understood it I would expect him to say the concept is inapplicable with a non convertible currency and floating exchange rate regime.

Richard Fisher.

The very fact that a Fed regional bank president has to raise this issue is not very comforting. It conjures up images of Argentina. And as Mr. Fisher explains, he’s not the only one worrying about it. He has just returned from a trip to China, where “senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature.” He adds, “I must have been asked about that a hundred times in China.”

Without knowing the right answer which is that lending is in no case reserve constrianed.
Causation runs from loans to deposits and reserves, and not from reserves to loans.

A native of Los Angeles who grew up in Mexico, Mr. Fisher was educated at Harvard, Oxford and Stanford.

Must have skipped the classes in reserve accounting.

He spent his earliest days in government at Jimmy Carter’s Treasury. He says that taught him a life-long lesson about inflation. It was “inflation that destroyed that presidency,” he says. He adds that he learned a lot from then Fed Chairman Paul Volcker, who had to “break [inflation's] back.”

Deregulating natural gas in 1978 is what broke the back of inflation as utilities switched from crude to natural gas and even cuts of 15 million barrels per day by OPEC were not enough to keep control of prices.

Mr. Fisher has led the Dallas Fed since 2005 and has developed a reputation as the Federal Open Market Committee’s (FOMC) lead inflation worrywart. In September he told a New York audience that “rates held too low, for too long during the previous Fed regime were an accomplice to [the] reckless behavior” that brought about the economic troubles we are now living through. He also warned that the Treasury’s $700 billion plan to buy toxic assets from financial institutions would be “one more straw on the back of the frightfully encumbered camel that is the federal government ledger.”

In a speech at the Kennedy School of Government in February, he wrung his hands about “the very deep hole [our political leaders] have dug in incurring unfunded liabilities of retirement and health-care obligations” that “we at the Dallas Fed believe total over $99 trillion.”

Hopefully he is worried about possible inflation and not solvency.

In March, he is believed to have vociferously objected in closed-door FOMC meetings to the proposal to buy U.S. Treasury bonds. So with long-term Treasury yields moving up sharply despite Fed intentions to bring down mortgage rates, I’ve flown to Dallas to see what he’s thinking now.

Hopefully he is concerned with the purchases possibly lowering interest rates too much for his liking and not about the size of the fed’s balance sheet.

Regarding what caused the credit bubble, he repeats his assertion about the Fed’s role: “It is human instinct when rates are low and the yield curve is flat to reach for greater risk and enhanced yield and returns.” (Later, he adds that this is not to cast aspersions on former Fed Chairman Alan Greenspan and reminds me that these decisions are made by the FOMC.)

“The second thing is that the regulators didn’t do their job, including the Federal Reserve.” To this he adds what he calls unusual circumstances, including “the fruits and tailwinds of globalization, billions of people added to the labor supply, new factories and productivity coming from places it had never come from before.” And finally, he says, there was the ‘mathematization’ of risk.” Institutions were “building risk models” and relying heavily on “quant jocks” when “in the end there can be no substitute for good judgment.”

Never does mention the role of fiscal policy. Like the massive 2003 retro tax cuts and spending increases that drove the next few years, including housing. Helped of course by the lender fraud.

What about another group of alleged culprits: the government-anointed rating agencies? Mr. Fisher doesn’t mince words. “I served on corporate boards. The way rating agencies worked is that they were paid by the people they rated. I saw that from the inside.” He says he also saw this “inherent conflict of interest” as a fund manager. “I never paid attention to the rating agencies. If you relied on them you got . . . you know,” he says, sparing me the gory details. “You did your own analysis. What is clear is that rating agencies always change something after it is obvious to everyone else. That’s why we never relied on them.” That’s a bit disconcerting since the Fed still uses these same agencies in managing its own portfolio.

Agreed. Can’t have it both ways. And now they are threatening to downgrade the US government as well

I wonder whether the same bubble-producing Fed errors aren’t being repeated now as Washington scrambles to avoid a sustained economic downturn.

He surprises me by siding with the deflation hawks. “I don’t think that’s the risk right now.” Why? One factor influencing his view is the Dallas Fed’s “trim mean calculation,” which looks at price changes of more than 180 items and excludes the extremes. Dallas researchers have found that “the price increases are less and less. Ex-energy, ex-food, ex-tobacco you’ve got some mild deflation here and no inflation in the [broader] headline index.”

Mr. Fisher says he also has a group of about 50 CEOs around the U.S. and the world that he calls on, all off the record, before almost every FOMC meeting. “I don’t impart any information, I just listen carefully to what they are seeing through their own eyes. And that gives me a sense of what’s happening on the ground, you might say on Main Street as opposed to Wall Street.”

It’s good to know that a guy so obsessed with price stability doesn’t see inflation on the horizon. But inflation and bubble trouble almost always get going before they are recognized. Moreover, the Fed has to pay attention to the 1978 Full Employment and Balanced Growth Act — a.k.a. Humphrey-Hawkins — and employment is a lagging indicator of economic activity. This could create a Fed bias in favor of inflating. So I push him again.

“I want to make sure that your readers understand that I don’t know a single person on the FOMC who is rooting for inflation or who is tolerant of inflation.” The committee knows very well, he assures me, that “you cannot have sustainable employment growth without price stability. And by price stability I mean that we cannot tolerate deflation or the ravages of inflation.”

Mr. Fisher defends the Fed’s actions that were designed to “stabilize the financial system as it literally fell apart and prevent the economy from imploding.” Yet he admits that there is unfinished work. Policy makers have to be “always mindful that whatever you put in, you are going to have to take out at some point. And also be mindful that there are these perceptions [about the possibility of monetizing the debt], which is why I have been sensitive about the issue of purchasing Treasurys.”

Yes, seems the Fed is worried about perceptions they know not to be true, but struggles to come with a way to communicate the operational realities.

He returns to events on his recent trip to Asia, which besides China included stops in Japan, Hong Kong, Singapore and Korea. “I wasn’t asked once about mortgage-backed securities. But I was asked at every single meeting about our purchase of Treasurys. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about.”

As I listen I am reminded that it’s not just the Asians who have expressed concern. In his Kennedy School speech, Mr. Fisher himself fretted about the U.S. fiscal picture. He acknowledges that he has raised the issue “ad nauseam” and doesn’t apologize. “Throughout history,” he says, “what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can’t let that happen. That’s when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can’t run away from it.”

Does not sound like he understands, operationally, what that is currently all about, but instead still uses gold standard rhetoric.

Voices like Mr. Fisher’s can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president. Does Mr. Fisher have any thoughts about that?

This is nothing new, he points out, briefly reviewing the history of the political struggle over monetary policy in the U.S. “The reason why the banks were put in the mix by [President Woodrow] Wilson in 1913, the reason it was structured the way it was structured, was so that you could offset the political power of Washington and the money center in New York with the regional banks. They represented Main Street.

Yes, there is a power struggle going on in the Fed

“Now we have this great populist fervor and the banks are arguing for Main Street, largely. I have heard these arguments before and studied the history. I am not losing a lot of sleep over it,” he says with a defiant Texas twang that I had not previously detected. “I don’t think that it’d be the best signal to send to the market right now that you want to totally politicize the process.”

Speaking of which, Texas bankers don’t have much good to say about the Troubled Asset Relief Program (TARP), according to Mr. Fisher. “Its been complicated by the politics because you have a special investigator, special prosecutor, and all I can tell you is that in my district here most of the people who wanted in on the TARP no longer want in on the TARP.”

At heart, Mr. Fisher says he is an advocate for letting markets clear on their own. “You know that I am a big believer in Schumpeter’s creative destruction,” he says referring to the term coined by the late Austrian economist. “The destructive part is always painful, politically messy, it hurts like hell but you hopefully will allow the adjustments to be made so that the creative part can take place.” Texas went through that process in the 1980s, he says, and came back stronger.

This is doubtless why, with Washington taking on a larger role in the American economy every day, the worries linger. On the wall behind his desk is a 1907 gouache painting by Antonio De Simone of the American steam sailing vessel Varuna plowing through stormy seas. Just like most everything else on the walls, bookshelves and table tops around his office — and even the dollar-sign cuff links he wears to work — it represents something.

He says that he has had this painting behind his desk for the past 30 years as a reminder of the importance of purpose and duty in rough seas. “The ship,” he explains, “has to maintain its integrity.” What is more, “no mathematical model can steer you through the kind of seas in that picture there. In the end someone has the wheel.” He adds: “On monetary policy it’s the Federal Reserve.”

Ms. O’Grady writes the Journal’s Americas column.

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This will allow them to raise rates simply by paying interest on reserves and not require them to first ‘unwind’ their portfolio as was the case in Japan.

Press Release

May 20 — The Federal Reserve Board on Wednesday announced the approval of final amendments to Regulation D (Reserve Requirements of Depository Institutions) to liberalize the types of transfers consumers can make from savings deposits and to make it easier for community banks that use correspondent banks to receive interest on excess balances held at Federal Reserve Banks.

The amendments would also ensure that correspondents that are not eligible to receive interest on their own balances at Reserve Banks pass back to their respondents any interest earned on required reserve balances held on behalf of those respondents. The Board is also making other clarifying changes to Regulation D and Regulation I (Issue and Cancellation of Federal Reserve Bank Capital Stock).

The Board has revised Regulation D’s restrictions on the types and number of transfers and withdrawals that may be made from savings deposits. The final amendments increase from three to six the permissible monthly number of transfers or withdrawals from savings deposits by check, debit card, or similar order payable to third parties. Technological advancements have eliminated any rational basis for the distinction between transfers by these means and other types of pre-authorized or automatic transfers subject to the six-per-month limitation.

The Board also approved final amendments to Regulation D to authorize the establishment of excess balance accounts at Federal Reserve Banks. Excess balance accounts are limited-purpose accounts for maintaining excess balances of one or more institutions that are eligible to earn interest on their Federal Reserve balances. Each participant in an excess balance account will designate an institution to act as agent (which may be the participant’s current pass-through correspondent) for purposes of managing the account. The Board is authorizing excess balance accounts to alleviate pressures on correspondent-respondent business relationships in the current unusual financial market environment, which has led some respondents to prefer holding their excess balances in an account at the Federal Reserve, rather than selling them through a correspondent in the federal funds market. A correspondent could hold its respondents’ excess balances in its own account at the Federal Reserve Bank; however, doing so may adversely affect the correspondent’s regulatory leverage ratio. As market conditions evolve, the Board will evaluate the continuing need for excess balance accounts.

In October 2008, the Board adopted an interim final rule amending Regulation D that directed Federal Reserve Banks to pay interest on balances held by eligible institutions in accounts at Reserve Banks. The final rule revises those provisions as they apply to balances of respondents maintained by “ineligible” pass-through correspondents–that is, entities such as nondepository institutions that serve as correspondents but are not eligible to receive interest on the balances they maintain on their own behalf at the Federal Reserve. Specifically, the final rule provides that only required reserve balances maintained in an ineligible correspondent’s account on behalf of its respondents will receive interest. Ineligible correspondents will be required to pass back that interest to their respondents. Both required reserve and excess balances in the account of an eligible pass-through correspondent will continue to receive interest and those correspondents are permitted, but not required, to pass back that interest to their respondents.

The final amendments to Regulations D and I will become effective 30 days after publication in the Federal Register. Excess balance accounts will be available for the reserve maintenance period beginning July 2, 2009.

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• ICSC UBS Store Sales WoW (Released 7:45 EST)
• ICSC UBS Store Sales YoY (Released 7:45 EST)
• Redbook Store Sales MoM (Released 8:55 EST)
• Redbook Store Sales MoM (Released 8:55 EST)
• ICSC UBS Redbook Comparison TABLE (Released 8:55 EST)
• Pending Home Sales MoM (Released 10:00 EST)
• Pending Home Sales YoY (Released 10:00 EST)

ICSC UBS Store Sales WoW (Mar 3)

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ICSC UBS Store Sales YoY (Mar 3)

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Redbook Store Sales MoM (Mar 3)

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Redbook Store Sales MoM (Mar 3)

 
Redbook up two weeks in a row?

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ICSC UBS Redbook Comparison TABLE (Mar 3)

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Pending Home Sales MoM (Jan)

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Pending Home Sales YoY (Jan)

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• Nonfarm Productivity QoQ (Released 8:30 EST)
• Nonfarm Productivity TABLE 1 (Released 8:30 EST)
• Nonfarm Productivity TABLE 2 (Released 8:30 EST)
• Unit Labor Costs QoQ (Released 8:30 EST)
• Unit Labor Costs ALLX (Released 8:30 EST)
• Initial Jobless Claims (Released 8:30 EST)
• Continuing Claims (Released 8:30 EST)
• Jobless Claims ALLX (Released 8:30 EST)
• Factory Orders YoY (Released 10:00 EST)
• Factory Orders MoM (Released 10:00 EST)
• Factory Orders TABLE 1 (Released 10:00 EST)
• Factory Orders TABLE 2 (Released 10:00 EST)
• Factory Orders TABLE 3 (Released 10:00 EST)

Nonfarm Productivity QoQ (4Q)

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Nonfarm Productivity TABLE 1 (4Q)

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Nonfarm Productivity TABLE 2 (4Q)

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Unit Labor Costs QoQ (4Q)

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Unit Labor Costs ALLX (4Q)

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Initial Jobless Claims (Jan 31)

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Continuing Claims (Jan 24)

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Jobless Claims ALLX (Jan 31)

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Factory Orders YoY (Dec)

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Factory Orders MoM (Dec)

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Factory Orders TABLE 1 (Dec)

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Factory Orders TABLE 2 (Dec)

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Factory Orders TABLE 3 (Dec)

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(email exchange - in response to previous email)

 
>   
>   On Thu, Jan 15, 2009 at 5:09 PM, Martin Wolf wrote:
>   
>   
>   Inflation is default.
>   

I respectfully do not agree.

Default is failure to make payment as agreed.

There is no zero inflation contract.

In fact, most every currency has inflation most years.

>   
>   Surely that is obvious to everybody.
>   

Credit default contracts don’t include inflation, nor does any other default provision.

>   
>   When the economy finally recovers, the government will end up with a very large debt.
>   

It will be some % of GDP that you may consider ‘very large’.

>   
>   Such debt is owed to bond-holders and serviced by taxpayers.
>   

In the first instance it is serviced by crediting accounts on the Fed’s own spread sheet.

If aggregate demand is deemed too high at that time future governments may opt to raise taxes.

If future govts desire to alter the distribution of real output to those then alive they will be free to do that via the usual fiscal and monetary measures.

>   
>   Politicians who are elected by the latter will want to default on liabilities to the former
>   (particularly if many of them are foreigners) and provide taxpayers with goodies, instead.
>   

Very possible!

>   
>   A burst of inflation is how they have always done it.
>   

Yes.

>   
>   End of story.
>   

As above. If you mean to say deficits will cause inflation, then do that.
Default is the wrong word for an international financial column.
Surely that’s obvious to everyone.

>   
>   I suggest you study the history of Argentina or indeed of the post-first-world-war inflations.
>   

And you can study what the ratings agencies have considered to be defaults.

 
All the best,
Warren

>   
>   Martin Wolf
>   

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Federal Reserve Press Release

Release Date: December 16, 2008

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Geitner ought to be able to hit that one..

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Aggregate demand continued to fall

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

Inventory liquidations to continue and OPEC not expected to hike prices

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Low interest rates per se are believed to promote growth and employment.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.

A larger balance sheet promotes growth, employment, and marketing functioning.

As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.

This implies the purchases have some benefit other than from keeping interest rates for these securities lower than otherwise, as it didn’t say the purpose was lowering mortgage interest rates.

The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Seems they still don’t grasp that it’s about ‘price’ (interest rates) and not ‘quantity’.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent.

They are still keeping it higher than the Fed Funds rates and still demanding collateral.

In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

No mention of the USD swap lines to foreign central bands that was last reported to be well over $600B.

Still no evidence of a working understanding of monetary operations and reserve accounting.

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(email exchange)

The Fed has no way of ‘pumping money into the economy’ = they only alter interest rates.

Except by making loans they don’t plan on collecting (the swap line advances to CB’s?)

Which is functionally equivalent to fiscal spending which does add income and financial assets to the economy.

>   
>   Rodger wrote:
>   
>   You and I were talking about a 0% fed funds rate. Almost there, now. Last I
>   heard, down to .25%. It will have no benefit. Wait, correction on that. There
>   will be one benefit. It gets us almost to the point where the Fed will stop
>   focusing on useless interest rate cuts, and start pumping money into the
>   economy. I hope.
>   
>   Rodger
>   

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“There are all sorts of technical ramifications when the fed funds rate goes towards zero. There are a lot of questions we’re going to have to grapple with going forward,” Plosser told reporters after a speech at the Economic Club of Pittsburgh. “You have to think about what this means for policy, market functioning, how we manage reserves.”

Yes, about time they thought about how reserve accounting works. They don’t have a clue. There are no operational issues.

But this does mean they may be reluctant to cut to zero.

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ECB to Cut Rates as Slump Calls for `Radical Action’

by Christian Vits

Nov. 6 (Bloomberg) — The European Central Bank will cut interest rates for the second time in less than a month today as the region’s economy suffers its worst slump in 15 years, economists said.

“It’s time for radical action,” said Ken Wattret, an economist at BNP Paribas SA in London. “This is a very severe economic downturn, interest rates should come down a long way.”

Obviously they still haven’t figured out lower rates will make matters worse, as lower rates cut government interest payments (it’s a spending cut) which removes income paid to the private sectors.

The only aspect that might help is the hope that the lower rates drive the currency lower. This is one of those ‘be careful what you wish for’ conditions.

First, with falling aggregate demand around the world, export growth will be problematic even with the lower real wages that come from a lower currency.

Second, a falling currency raises import prices and reduces real terms of trade, particularly for a large energy importer like the eurozone.

Third, anything that weakens the economy and lowers standards of living is socially dangerous.

Fourth, the problems of USD debt including USD losses growing as a % of euro based capital and income that have been driving the euro down remain and the risk of an acceleration of this process increases as the eurozone economies weaken.

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(email exchange)

Yes, a very obvious move for anyone with any sense of logic.

Again, we see continued evidence that the higher ups do not understand their own monetary operations.

Some of the remaining issues:

The TAF should at a minimum be unlimited and offered at a fixed rate, and the collateral requirements can be expanded to any bank legal assets.

The Fed should get Congressional approval to expand their treasury lending facility and lend any security in unlimited quantities at an overnight rate at a small
spread below their target Fed funds rate.

The Fed should cut off the (unlimited) swap lines to foreign central banks before it’s too late.

>   
>   On Wed, Nov 5, 2008 at 11:43 PM, Scott wrote:
>   

Press Release

Federal Reserve Press Release

Release Date: November 5, 2008
For release at 10:00 a.m. EST

The Federal Reserve Board on Wednesday announced that it will alter the formulas used to determine the interest rates paid to depository institutions on required reserve balances and excess reserve balances.

Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6.

The Board judged that these changes would help foster trading in the funds market at rates closer to the FOMC’s target federal funds rate.

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>   
>   On Wed, Nov 5, 2008 at 7:06 AM, Morris wrote:
>   
>   COLLAPSE OF ST RATES HAS DONE SQUAT FOR LT RATES- so consumer
>   has gotten no benefit in trying to procure Long Term financing especially
>   in housing, where all mtge rates are near the high for the last 52 wks–
>   the spread between Fed Funds to Jumbo Mortgages is now 680bps–
>   has got to be a record… Great for spreads at banks…not great for
>   consumers..
>   

And banks are not allowed to take ‘gap’ risk so it doesn’t do much for them, either.

Short rates are down because of Fed funds cuts by the Fed and the unlimited lending internationally via the swap lines bringing down three month rates.

To bring long term rates down they need to stop issuing long term Treasury securities and buy back the stuff that’s outstanding. Treasury securities function as ‘interest rate support’ for their given maturity.

But even lower long term rates won’t do a lot when there is a shortage of aggregate demand because the budget deficit is too small.

And an unfriendly foreign monopolist setting crude prices can only be addressed by immediately cutting our consumption.

Warren

MOSLER’S LAW: There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it.
(as stated by Prof. James Galbraith)

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Yes, but, of course, for the wrong reasons!

They all still act and forecast as if lower rates are expansionary.

This still has no support in theory or practice.

Outstanding government debt means the private (non-government) sectors are net savers.

Households remain net savers.

Lower rates directly cuts personal income.

And lowers costs for businesses including costs of investments that reduce costs.

I do favor a permanent zero interest rate policy.

That would mean the same amount of government spending needs less in taxes to support it (larger deficit).

Ex-Fed Gov. Meyer Makes a Case for a Zero Fed-Funds Rate

By Brian Blackstone

With the U.S. unemployment rate now expected to climb well above 7%, former Federal Reserve governor Laurence Meyer projects that Fed policymakers may have to lower the target federal-funds rate all the way to zero next year.

“However, the expected rise in the unemployment rate, paired with the rising threat of deflation, presents a risk that the FOMC will have to ease even further, perhaps all the way to a zero federal funds rate,” Meyer and Sack wrote in a research note.

Meyer and Sack said they think the jobless rate will rise to as high as 7.5% from 6.1% now. They also expect a significant gross domestic product contraction of 2.8%, at an annual rate, in the fourth quarter, after a projected 0.7% decline in the third. They also expect GDP to fall in the first quarter of next year.

Meyer and Sack expect the Fed’s preferred inflation rate gauge — the price index for personal consumption expenditures excluding food and energy — to moderate to just 1% growth, at an annual rate, by the end of 2010.

“Plugging our interim forecast into our backward-looking policy rule suggests that the federal funds rate should be cut to zero by the middle of next year,” Meyer and Sack wrote.

“Our forward-looking policy rule…gives similar results if we plug in our updated forecast, as it calls for a funds rate of about zero by early 2010,” they wrote.

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(email exchange)

And this only makes it worse:

Hungary Raises Benchmark Rate to Defend its Currency (Update2)

By Balazs Penz and Zoltan Simon

Oct. 22- Hungary’s central bank raised its key interest rate in an emergency measure to shore up the country’s currency, after it fell to near a record against the euro.

The Magyar Nemzeti Bank in Budapest raised the two-week deposit rate today to 11.5 percent, the highest since July 2004, from 8.5 percent, it said in an e-mailed statement. The move came two days after the bank left rates unchanged at its regular meeting. The last emergency rate increase was in 2003.

Governments are net payers of interest, so raising rates adds to governments spending on interest and raises costs of doing business and costs of investments- all ‘inflationary biases’ that further weaken the currency.

And a weaker euro (just saw it at about 129) means unrealized dollar losses across the Eurozone grow as a percentage of (eurodenominated) capital, pushing the banking system and the national governments pledged to support it towards insolvency.

>   
>   On Wed, Oct 22, 2008 at 3:08 AM, wrote:
>   
>   I wonder whether this will prove a tipping point for the euro:
>   The willingness of the ECB to “bail out” a country that is not
>   yet member of the Eurozone is quite significant and signals the
>   concerns that EMU members now have about the disruptive
>   effects of a crisis in Hungary. Of course, they can do it now
>   that the have the sub-underwriter of last resort in the Fed.
>   Also, the ECB liquidity support, unlike IMF conditionality loans,
>   does not come with any attached string. The additional issues
>   that the ECB action has caused are however important: if 5
>   billion is not enough if the financial pressures intensify would
>   the ECB lend more? Will the ECB do similar swaps with other
>   Emerging Europe economies that are likely candidates – in the
>   next few year - for EMU membership? Also should Hungary now
>   use this additional international liquidity to prevent a further
>   depreciation of its currency or should it save this additional
>   ammunition in case things get worse?
>   

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I’m keeping an eye on crude prices rising a lot more than the USD is falling; so, I suspect the great Mike Masters inventory liquidation has run its course.

Inventories are at record or near record lows.

If there has been net demand destruction, it hasn’t yet showed up in OPEC or Saudi production numbers.

The Saudis only pump on demand, at their price, so as swing producer it’s their production that should fall, not anyone else’s.

However, there can be 90 day type lags; so, October Saudi production could be down but not be reported until early November.

___________________________________________________________________________________________________________________

This latest swap line expansion should be a target of Obama and McCain, but neither are touching it.

It’s a financial blunder, potentially of epic magnitudes.

It’s also an oversight issue of epic magnitudes that could dwarf the subprime issue at the first ECB USD auction tomorrow.

The $620 billion swap lines currently in place could swell to well over a trillion USDs.

It will reduce eurobanks cost of USD funds, bring down LIBOR, and normalize bank liquidity.

And the reduction of bank credit risk is bringing in credit spreads which makes room for equities to appreciate as well.

But that’s an empty victory that changes the lack of aggregate demand very little, if any.

And it adds a new element of systemic risk.

Unrestricted/’currency secured’ international USD lending has been tried before in the emerging markets.

Yes, this type of initial lending reduces financial stress, but then it must be sustained and increased to avoid a subsequent collapse, which then becomes inevitable.

Remember Mexico and the rest of Latin America?

It took a growing level of external USD debt to hold it together, until the number got too large and the controls impossible. And then it all fell apart.

All of these ‘top down’ measures that carry the hopes and anticipations of markets should continue to be let downs as no one addresses demand.

This happened in Japan after the banks were recapitalized and ‘healthy’ and nothing happened regarding lending.

Obama and McCain have a window to jump on this opening but don’t seem to be. McCain as the watchdog and Obama as the reformer are both letting us down. Again, as they show no insight and instead keep to their canned rhetoric.

Bush and congress missed a historic opportunity to move the US away from ‘materialism’ after 9/11.

I got a call from Congressman Gephart at the time, and I said this is an opening to show a different kind of leadership as people had turned ‘inward,’ with the following type of statement:

A nation is not richer because people sleep in hotels instead of staying at home. A nation is not richer because we eat out rather than have family meals at home. And now that we have become more introspective on life itself, we can continue this enlightened change of course, back to our real core values, and steer our efforts to educating our children and improving our health care service, etc. etc.

But instead, our leadership telling us:

“Get out of Church and get into the shopping malls!” in order to ’save the economy’, etc. etc. Gephart didn’t do it. And we went back to the malls.

This go round was also an opportunity to make a fundamental change away from a lending based model to a more cash based model which seems to me has proven more stable over time and a lot more beneficial to human peace of mind.

We could have let most of our lending institutions go by the wayside and kept the banks that would be allowed to make more conservative home loans, installment loans, checking and savings accounts, and not much else. And the housing agencies operating a bit like the old savings and loan’s used to do, but this time with sustainable, matched treasury funding.

And rather than relying on lending for aggregate demand, which is inherently unstable, we could have supported aggregate demand with a fiscal package to provide sufficient income to buy our output and sustain growth and employment.

But instead we are first ‘fixing’ the lending institutional structure, without addressing aggregate demand.

It’s unlikely that costly (in terms of lost output and employment) credit bubbles will be reduced by first supporting the lending institutions and then supporting demand.

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Highlights

China to Slash Rates, Spend to Fuel Growth, Morgan Stanley Says

2008-10-07 03:11:05.320 GMT
By Kevin Hamlin

Oct. 7 (Bloomberg) — China will cut interest rates as many as five times by the end of 2009 and will step up spending to limit the effect of the “global financial tsunami” on the nation’s economic growth, Morgan Stanley said.

The central bank will cut borrowing costs by 27 basis points each time, reducing the one-year lending rate to as low as 5.85 percent next year from 7.2 percent now, Qing Wang, a Hong Kong- based economist, said in a note today. Government spending may add as much as 3 percentage points to economic growth, he said.

Global growth is slowing after the collapse and bailout of banks in the U.S. and Europe propelled the cost of borrowing in money markets to the highest ever. Slowing economic growth in Europe and the U.S., which account for 40 percent of China’s total exports, will translate into lackluster exports, falling corporate profit and easing inflation, Wang said.

“A substantial improvement in the inflation outlook should help ease the lingering concerns about the inflationary consequences of an expansionary macroeconomic policy,” Wang said. “We expect a decisive policy shift toward boosting growth in the coming weeks and months.”

Wang cut his forecast for inflation next year to 2.5 percent from 4 percent. He lowered his estimate for economic growth in China next year to 8.2 percent from 9 percent and lowered his forecast for this year to 9.8 percent from 10 percent.

More spending and tax cuts would contribute between 1 and 3 percentage points to growth, Wang said.

China can “afford to run multiyear fiscal deficits without running into debt sustainability problems,” because it has public debt of only 30 percent of gross domestic product, Wang said.

Property Market Risk

The main risk to his forecast was a “meltdown” in the property sector across the country, “which would lead to a massive collapse in real-estate investment, Wang said.

The consequences would be so serious that even pro-growth policies wouldn’t prevent the economy growing less than 7 percent, he said.

The probability of this happening is less than 25 percent, Wang estimated, contradicting a Sept. 12 report by Jerry Lou, a Morgan Stanley strategist, who said the “likelihood of a property sector meltdown is high.”

China thus has ample room for monetary and fiscal initiatives to help offset the impact of slower global growth, he added. This would entail “unwinding” tightening measures introduced since last year, including “the 162 basis points interest rate hike, the 850 basis points hike of the required reserves ratio, and stringent administration bank lending quotas,” he said.

The People’s Bank of China cut the one-year lending rate to 7.20 percent from 7.47 percent, the first reduction in six years, last month.

Morgan Stanley forecasts that the U.S. economy will contract by 0.2 percent next year and that growth in the Europe will reach only 0.2 percent. It expects a 1 percent contraction in Japan.

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